When Hosts Attack: The Competitive Threat of Online Platforms

Online retail platforms like Amazon are great for the third-party businesses that use them—until the platform’s owner decides to start competing with them. Feng Zhu looks at the factors that turn hosts into predators.

by Carmen Nobel

In the online marketplace, oodles of retailers and developers rely on “platforms” such as Amazon.com, the Apple App Store, Facebook, and Twitter to get their products and services into the hands of users. Retailers, for example, sell items on Amazon to extend their reach to more potential buyers; application developers turn to the App Store for digital distribution. The platform providers are their selling partners, scraping off a little bit for themselves on each sale.

It’s a great arrangement for small businesses—until their hosts decide to start competing with them.

“Millions of businesses are building their services around these platforms,” said Harvard Business School assistant professor Feng Zhu, during a presentation at Future Assembly, an event at Harvard Business School where business leaders and academics discussed the challenges of operating in a digitally-transformed economy. “A platform owner may imitate them and enter their markets by offering similar products,” Zhu explained.

“Before you build your business model around platforms, you need to think about how to minimize the risk from these platforms”

History has documented many such skirmishes. Netscape, designed to run on Microsoft’s Windows platform, was the dominant web browser in the 1990s until squashed by Microsoft’s own Internet Explorer. In February 2015 there was the launch of Meerkat, an app that lets users broadcast live streaming video through their mobile devices via Facebook or Twitter. A month later Twitter acquired competing app Periscope and cut off Meerkat’s access to Twitter’s social graph. And then there was the iPhone flashlight app from Noah Corp., which you’ve likely never heard of because Apple now includes a flashlight as a standard feature on the iPhone.

Thus, third-party sellers find themselves operating in an environment where their hosts could become enemies at any time, and they must figure out a defensive strategy. But platform operators have some strategizing to do as well, deciding when and whether it makes sense to compete against their own customers.

To analyze the competitive landscape of platforms, Zhu delved into data from Amazon.com, which serves both as the biggest online retailer in the United States and as a platform on which third-party retailers can sell their wares directly to customers. He reported his findings in the paper “Competing with Complementors: An Empirical Look at Amazon.com,” co-written with Qihong Liu, an associate professor of economics at the University of Oklahoma.

In June 2013, Zhu and Liu identified 163,853 products for sale by third-party retailers via Amazon’s Marketplace that were not yet sold directly by Amazon.com itself. Ten months later, in April 2014, they looked at the same products and found that Amazon had started directly selling 4,852—or 3 percent—of the very same products.

Next, the researchers set out to determine why Amazon had decided to sell these particular products directly. In terms of product categories, they found that, on average, the products Amazon chose tended to have higher retail prices and lower shipping costs than those it didn’t choose, which makes sense because Amazon offers free shipping on orders over $35. Also, Amazon was more likely to start selling products already offered by many sellers, which suggested these products were easy to obtain from their manufacturers.

Protecting against predators

So what can companies do to protect themselves from this competitive threat? In their paper, Zhu and Liu explain that third-party sellers can try to sign exclusivity contracts with manufacturers, although asking a manufacturer not to sign with Amazon, for example, might be a tough sell.

In cases where the third parties develop products themselves, as is the case with many mobile apps, companies may be able to stave off platform competition by securing patents for their innovations before bringing them to market.

The general lesson for any company that depends on distribution partners: Be wary. As Zhu told the audience at Future Assembly: “Before you build your business model around platforms, you need to think about how to minimize the risk from these platforms.”